Stock options trading systems bet on volatility, not just stock price. Complex positions like butterflies and iron condors aim to make pure volatility bets. Delta neutral is a popular approach, but fees and volatility cycles can be problematic. Exploiting option pricing errors requires a lot of money and time.
A stock options trading system bets on the increase or decrease in volatility. To the casual observer, options look like bets that the stock will rise or fall, but in reality they are bets that the price will rise or fall faster than expected. In other words, call buyers bet that stock prices will rise faster than the premium predicted, while put buyers bet that stock prices will fall faster than expected when the premium was set.
All the slight variations on a stock options trading system produce a plethora of complex positions with names like butterflies, iron condors and reverse butterflies. These complex positions are usually an effort to make a pure volatility bet with indifference to direction. All of these strategies can be successful if you don’t have to pay commissions. It is easy enough for a complex position to generate commission costs so high that even if the underlying stock performs as expected, the trader loses money. If the underlying stock doesn’t perform as expected, the trader loses even more money.
One of the most interesting phrases in options trading is “delta neutral”. In options, it is essentially the same thing as betting that volatility will decrease. According to the theory, if a stock options trading system constantly rebalances its portfolios to remain delta neutral, over time premiums will accrue to the account that the system is trading, no matter how the stocks underlying the options move. . There are two main problems with a delta neutral approach: fees and the somewhat cyclical nature of volatility. Betting that volatility will decrease can be very difficult and expensive to sustain when volatility is on the rise.
One final approach that a stock options trading system can use is to look for off-the-money positions that are priced incorrectly. Theoretically, mispricing of deep out-of-the-money options is common for reasons having to do with the math of option pricing. The theory is that you will buy these options cheap, inevitably getting paid over the long term when volatility increases enough to make them valuable. Exploiting option pricing errors requires an immense amount of money and a very long time frame. You can buy all the badly wrong options in the market and not make a profit for years, as at least one big fund has done.
Smart Asset.
Protect your devices with Threat Protection by NordVPN
